Erm in an Optimal Control Framework

Much of ERM consists of qualitative discussion of the risks facing a business and controls over them. It is difficult to identify in the literature a clear body of theory to provide the foundation for the subject, integrating a business’s objectives with its risk controls. The present paper attempts this by formulation of ERM as an exercise in stochastic optimal control theory. Here there is a defined objective, which would usually include some aspect of profit, and a set of constraints (the risk controls). Optimal control theory provides a framework for balancing the one against the other, and also for considering whether or not particular risk controls are well advised. The paper accepts the COSO (2004) definition of ERM, and its associated ERM Integrated Framework. After definitions, preliminary discussion and establishment of the control theory set-up, the paper is organised with one section for each item of the ERM Integrated Framework. Each of these sections interprets that item within the control theory model.